Exchange-traded funds (ETFs) can be used as building blocks for almost any type of investment goal, from the most basic to highly sophisticated hedging.
There were 2,567 ETFs on the market as of June 30, 2021, with almost $6.58 trillion of assets under management. Learn about ETF strategies and how you can use them in your portfolio.
- ETFs are cost-effective ways to invest in many securities at once while still having the liquidity of owning individual stocks.
- Index ETFs follow a large stock index such as the S&P 500, while multi-asset ETFs hold stocks, bonds, and real estate in a single fund.
- You can choose ETFs based on how much risk you want to take on, including leveraged ETFs, international ETFs, or risk management ETFs.
- Some ETFs focus on certain sectors, or they might hold only socially responsible securities. They let you create a portfolio that aligns with your values.
Why ETFs Are Good for Your Portfolio
ETFs are an affordable way to invest in many stocks, bonds, or other assets. They give you diversification and professional money management. Baskets of securities are traded on exchanges such as the Nasdaq and the New York Stock Exchange (NYSE).
ETFs are liquid, just like individual stocks. They often have very low expenses. Purchase levels are low as well. ETFs publish their holdings daily.
You can use ETFs to pursue a basic investment goal with very little money if you're just getting started.
Diversifying Your Portfolio
Diversifying your portfolio into asset classes such as stocks, bonds, or real estate allows you to get the most return for the amount of risk you're willing to take. A basic mix might include domestic stocks, international stocks, and bonds. Conservative investors will have more bonds in their portfolios. Aggressive investors will have more stocks, with a higher number that are international. A multi-asset ETF could be a good place to begin if you're just getting started.
A multi-asset ETF includes types of assets such as stocks, bonds, real estate, or cash within a single fund. The fund managers decide where to invest. They decide how much to invest toward your investment goal.
An aggressive multi-asset ETF with a goal of capital appreciation might include emerging markets and small-capitalization stocks. A conservative multi-asset ETF with a goal of earning income might include investment-grade bonds and blue-chip stocks.
Basic Index ETFs
More experienced investors can build their own portfolios using indexed ETFs. These ETFs hold investments that match the returns of a financial index, such as the S&P 500 or the Bloomberg U.S. Aggregate Bond Index.
Index ETFs are a simple way to invest in broad segments of the stock, bond, real estate, and commodities markets.
Style and Factor ETFs
Investment styles within asset classes will often perform differently depending on the economic conditions. Stocks are often classed by capitalization size (small, medium, or large) and as value or growth investments. Fixed-income styles are classed by interest-rate sensitivity and credit rating.
ETFs are available for any investment style. You can invest in ETFs that track the CRSP (Center for Research in Securities Prices) small-cap value stock index. Another choice could be an ETF that tracks the Bloomberg Capital U.S. High Yield Corporate Bond Index. This will invest only in high-yield bonds. Factor ETFs focus on companies that have certain financial or trading characteristics, such as strong balance sheets or an upward price trend.
You can use sector and industry ETFs to align your holdings with the stages of the business cycle. Utilities and consumer staples perform well during recessions, while the consumer discretionary sector does well during expansions.
Each sector of the economy is tracked by an index, and some industries within those sectors are tracked as well. There are ETFs for all sectors and industries, from e-commerce to energy.
Economic and political conditions can favor some areas of the world more than others at any given time. You can use international ETFs to capitalize on growth opportunities in different countries and regions. The largest international ETF tracks the FTSE index of developed countries other than the U.S.
Socially Responsible ETFs
Socially responsible investing evaluates companies based on how well they support environmental, social, and governance (ESG) issues. The firm MSCI rates 14,000 companies for social responsibility and publishes indexes that track these characteristics. There are about 150 socially responsible ETFs available on the U.S. markets.
Risk Management ETFs
You can use ETFs to hedge against markets that are moving downward. Inverse ETFs show gains when an index is down. They show losses when it's moving up. Common inverse ETFs track the S&P 500. Long/short ETFs in this category buy and short-sell underlying investments based on share-price factors.
Long/short funds try to maximize the upside of a market by purchasing shares that are undervalued. They attempt to limit risk by short-selling shares that are overvalued.
Leveraged ETFs are right for experienced investors who understand their risks. These ETFs are designed to deliver a multiple of an index return on a daily basis. A 2x S&P 500 ETF is designed to double the S&P 500 return daily.
Leveraged ETFs use debt, options, short-selling, and other methods to reach their goals. Leveraged ETFs magnify both gains and losses.
The Bottom Line
ETFs let new investors take advantage of professional money management. Seasoned investors can use them to capitalize on certain areas of opportunity based on conditions. ETFs can also be used for highly sophisticated leveraged and short-selling strategies. They're liquid, cost-effective, and transparent. They can be used as building blocks for any investment strategy, and to take advantage of opportunities in any market, region, or sector.
Do your research before you invest. Know how much risk you're comfortable with. Think about getting help from a professional financial advisor if you're new to investing.